Why Creditors MUST Suffer Also

[girl gone mad]

http://www.ritholtz.com/blog/2009/04/why-creditors-must-suffer/">The Big Picture:

Why Creditors MUST Suffer Also

I frequently disagree with Tyler Cowen — our world economic views are quite different, as are, I assume, our politics. But his column in the http://www.nytimes.com/glogin?URI=http://www.nytimes.com/2009/04/05/business/economy/05view.html&OQ=_rQ3D1&OP=70f16cf3Q2FQ27h3fQ27e7vJs77SQ23Q27Q23ccQ5BQ27cQ60Q27cQ7BQ27fdJlN3JJQ273v7N7Q3CqQ27cQ7Btl3hQ22kSQ3CQ26">Sunday Times today, I can find at least one major area where we are sympatico:

“But there is a big hole in these proposals, as there has already been in the government’s approach to bailing out failing financial companies. Even as they focus on firms deemed too big to fail, the new proposals immunize the creditors and counterparties of such firms by protecting them from their own lending and trading mistakes.

This pattern has been evident for months, with the government aiding creditors and counterparties every step of the way. Yet this has not been explained openly to the American public.

In truth, it’s not the shareholders of the American International Group who benefited most from its bailout; they were mostly wiped out. The great beneficiaries have been the creditors and counterparties at the other end of A.I.G.’s derivatives deals — firms like Goldman Sachs, Merrill Lynch, Deutsche Bank, Société Générale, Barclays and UBS.

These firms engaged in deals that A.I.G. could not make good on. The bailout, and the regulatory regime outlined by Timothy F. Geithner, the Treasury secretary, would give firms like these every incentive to make similar deals down the road.

That is a huge flaw in the Paulson plan, now adopted by Geithner.

Tyler’s suggestion? Worry less about executive pay, and more creditor bailouts:

“Restricting compensation at these creditor firms would have more force — if it is done transparently, in advance and in accordance with the rule of law. A simple rule would be that some percentage of bailout funds should be extracted from the bonuses of executives on the credit or counterparty side of transactions.”

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